The Corporate Tax Planning Law Review: Australia
Consistent with broader OECD trends, Australia is continuing to focus on the taxation of multinational entities. The stated goal of the Australian Taxation Office (ATO) is to close the tax gap between theoretical expected revenue and tax collected.
This has involved a three-pronged approach, addressing existing anti-avoidance rules, amending the treaty network through the Multilateral Instrument (MLI) and a new enforcement ethos.
We expect this approach to continue, particularly with the enactment of new integrity rules, more active and tailored ATO compliance activity and new whistle-blower protections.
The ATO is pursuing more robust approaches to contemporaneous auditing, information-gathering and data-matching to close the tax gap. The ATO is also increasingly willing to strategically litigate disputes.
This section describes the 'justified trust' framework and developments in tax administration, which will lead to fewer opportunities for future tax planning.
i Justified trust
The ATO has adopted the OECD concept of 'justified trust' in its assurance approach. Under 'justified trust', the ATO seeks objective evidence from taxpayers that would lead a reasonable person to conclude that the taxpayer has paid the right amount of tax and met their tax obligations in a timely and transparent manner.
Justified trust focuses on obtaining assurance that:
- the taxpayer has a tax risk management and governance framework that is applied in practice;
- none of the specific tax risks communicated by the ATO to the market are present in the taxpayer's circumstances;
- the tax outcomes of any significant, new or atypical transactions are appropriate; and
- any variance between accounting and tax results is explainable and appropriate.2
The ATO applies its justified trust approach in its 'Top 100'3 and 'Top 1,000' programmes.4 Under both programmes, specialist tax performance teams are assigned to each taxpayer for intensive, tailored assurance reviews.
The justified trust approach is supported by ATO compliance activity (such as reviews, audits and litigation), active prevention activities across the market5 and the production of justified trust review documents, which are shared with the taxpayer's board to encourage active tax risk management.
ii Litigation, information gathering and legal professional privilege
The ATO has been pursuing a strategic litigation approach for several years and is increasingly willing to litigate disputes with taxpayers to resolve conflicting interpretations of tax laws.6
The ATO's statutory information gathering powers include the ability to issue formal notices, colloquially referred to as 'Section 353-10 notices'.7 These notices may require the production of information and documents, the attendance of nominated persons for interview or a combination of these. Section 353-10 notices are limited in scope to documents and personnel in Australia, however, the ATO may also issue 'Section 353-25' offshore information notices to overseas entities.8
Taxpayers failing to meet the requirements of Section 353-10 notices may be subject to a fine, and in extraordinary cases, imprisonment, though such enforcement is quite rare. No penalties or criminal sanctions are applicable for failure to comply with a Section 353-25 notice; however, refusing or failing to provide the requested information will mean that the same information is subsequently inadmissible without the ATO's consent in judicial proceedings challenging assessments.
The ATO's information gathering powers are limited by legal professional privilege (LPP) under common law.
LPP does not apply to communications between accountants and their clients. However, as administrative concessions (which can be lifted),9 the ATO:
- accepts that certain documents between taxpayers and external professional accounting advisers should be treated as confidential;10 and
- will not, in practice, request access to advice that is provided by in-house counsel or external accountants and tax agents, where the advice is provided for the sole purpose of advising a corporate board on tax compliance risk.11
The ATO is targeting blanket unwarranted LPP claims being made over documents that do not contain independent legal advice or that contain aggressive tax planning arrangements disguised as privileged documents.12 To improve the process of claiming LPP, the ATO has established an LPP working group,13 comprising senior ATO members and associations representing the Australian accounting, tax and legal professions.14
The ATO's stance is supported by the 2019 Glencore case.15 In this case, Glencore sought an injunction restraining the ATO from using certain 'Paradise Papers' documents said to have been stolen from Bermudan law firm Appleby in a cyberattack and leaked to the global press. The High Court of Australia held unanimously that LPP is only an immunity from the exercise of statutory powers that would otherwise compel the disclosure of privileged communications and is not an actionable legal right enforceable by injunction. In other words, LPP can only be used as a defensive 'shield' rather than as a 'sword'. As the documents were already in the public domain and in the ATO's possession, Glencore could not obtain an injunction to restrain the ATO's use of the documents.
iii Cooperation with other government agencies
Increasingly, the ATO is coordinating with other government agencies, including the Foreign Investment Review Board (FIRB), to obtain advance warning of significant transactions that may impact revenues.
FIRB is the government agency responsible for examining proposals by foreign investors to acquire interests in Australian real estate (including agricultural land and water entitlements). FIRB makes a recommendation to the Australian Treasurer on whether to approve foreign investment and any conditions attached to the approval.
FIRB consults the ATO in the approval process to determine the potential tax impact of proposed foreign investment. The ATO provides a risk rating for the proposed transaction and may advise FIRB to impose tax conditions.16 This process gives the ATO considerable leverage to obtain information at the time of implementation.
A breach of tax conditions may lead to prosecution or a divestment order. FIRB may also impose other obligations on the investor, such as supplying certain information or requiring an ATO ruling be obtained.
iv Entity selection and business operations
Australia is a federation in which powers, including taxation powers, are divided between the federal government and the state and territory governments.
Income taxes17 are imposed by the federal government and collected by the ATO, led by the Commissioner of Taxation (Commissioner).18 No state or territory government imposes income tax; however, they each impose their own taxes, including stamp duty, land tax, motor vehicle transfer duty and payroll tax.19
Income tax operates on residency and source bases. Residents of Australia are generally taxed on worldwide income. Non-residents are taxed on Australian-sourced income.
Australia operates a self-assessment income tax system. Companies are generally subject to a 'full' self-assessment system requiring companies to self-assess their tax liability and report this information to the ATO by lodging their taxation returns.20
Indirect federal taxes, such as the broad-based value-added tax, called the Goods and Services Tax (GST) imposed at 10 per cent, are also self-assessed.
Returns may be audited by the ATO and amended generally within four years of assessment. An unlimited period of review applies in cases of 'fraud or evasion' by the taxpayer.21
Businesses are required to register for pay-as-you-go (PAYG), a single integrated system for withholding amounts from certain types of payments including:
- business and investment income;
- wages and salaries paid to employees;22 and
- payments to other businesses that do not quote their Australian Business Number (ABN).
A reporting framework called 'Single Touch Payroll' applies to all employers and operates by electronically transmitting payroll information in real time to the ATO when wages, salaries and other amounts are paid to employees.
A compulsory superannuation system operates in Australia. Generally, where an employee earns A$450 or more pre-tax income in a calendar month, employers are required to pay 9.5 per cent23 of an employee's ordinary time earnings24 to a complying superannuation fund of the employee's choice. Complex rules and concessions apply to superannuation contributions and income derived by funds.
Tax concessions are available to not-for-profit organisations, including an income tax exemption. These generally require satisfaction of purposive criteria and registration with relevant authorities.25
Australian businesses are commonly structured as companies, partnerships or trusts (including 'managed investment trusts'). All entities must register with the ATO26 and lodge annual income tax returns.
No check-the-box election is available. However, entity selection remains a choice for business owners, with taxation treatment generally following the nature of the entity. The ATO has scrutinised the use of multiple layers of entities, for example, establishing a head company and subsidiary to allow for tax consolidation in an acquisition scenario.27
Partnerships and trusts
Partnerships (other than limited partnerships) are fiscally transparent, with partners being subject to tax on their allocation of income in accordance with a partnership agreement.
Trusts are generally fiscally transparent.28 Beneficiaries that are 'presently entitled' to trust income are usually subject to tax on their share of the trust's taxable income.29 Trusts should annually distribute their income to beneficiaries as trustees failing to do so will be assessed on accumulated income.30
Companies are not fiscally transparent and pay corporate tax.
An imputation system applies to distributions31 paid by Australian-resident companies. Under this system, refundable tax credits are available32 to Australian-resident shareholders for underlying Australian corporate tax paid on any 'franked' distribution received. This is intended to alleviate double taxation that occurs under a classical dividend system.33 Shareholders are taxed on 'unfranked' dividends at their marginal tax rate.
Draft legislation for a proposed Corporate Collective Investment Vehicle (CCIV) regime was circulated in January 2019 but has not been enacted.
CCIVs are intended to be a new type of company readily marketable to foreign investors, including through the Asia Region Funds Passport.34
Australia's foreign hybrid rules37 operate to treat foreign companies and foreign limited partnerships (LPs) controlled by Australians as partnerships for Australian income tax purposes. This impacts the nature of distributions received by Australian members in the foreign hybrid entity.38
Choice of entity
Entity choice is generally linked with the character of the investors and the underlying assets. The default vehicle for trading businesses is a company, as it can retain cash without penalty and pay franked distributions.
Outbound investments from Australia are typically structured through companies as they have access to participation exemptions for non-portfolio dividend income39 and capital gains on disposal of shares in foreign companies carrying on active foreign businesses.40
Unit trusts are routinely used in the property sector as they have the following advantages: trusts can pay 'tax deferred' distributions41 to members; and widely held property trusts can qualify as managed investment trusts (MIT).42
Discretionary trusts are generally used in private groups to assist in income-splitting between family members.43
Domestic income tax
Australian-resident companies are taxed on worldwide income at the flat rate of 30 per cent, however, those qualifying as 'base rate entities' are eligible for a reduced rate of 27.5 per cent.44 Companies do not benefit from the 'tax-free threshold' for Australian-resident individuals.45
Foreign companies are taxed on Australian-sourced income at a flat rate of 30 per cent.
Subject to integrity rules,46 individuals are entitled to a 50 per cent discount on capital gains made on assets held for at least 12 months, including where the gain flows through a trust.47 Companies and non-residents are not entitled to this discount.
Australian residents are taxed on foreign-sourced income.48 Double taxation is addressed through an extensive treaty network (currently being updated under the MLI) and credits for foreign tax paid.49
Offshore profits may be repatriated to an Australian company by payment of exempt non-portfolio dividends, however, subsequent dividends paid by the Australian company will be subject to tax at marginal rates in Australia, unless franking credits are otherwise available. This effectively means that these participation exemptions merely defer Australian tax for Australian-resident shareholders in respect of interests in foreign companies.
Non-residents who receive an unfranked dividend sourced from offshore exempt dividends do not pay any Australian dividend withholding tax under the conduit foreign income regime.50 This is intended to promote Australia as a holding company jurisdiction, although the success of this policy is unclear.
Australian branches of foreign subsidiaries are generally subject to tax at the corporate rate on income connected with the permanent establishment (PE).51 These profits can then be repatriated offshore free of further Australian tax.
Taxation of foreign income has been an area of significant legislative change, including new integrity rules targeting profit-shifting and avoidance within multinational groups or 'significant global entities' (SGEs).52
SGEs are subject to additional reporting, integrity measures including the Diverted Profits Tax (DPT) and the Multinational Anti-Avoidance Law (MAAL) and increased penalties.
An SGE is an entity that is:
- a 'global parent entity'53 with annual global income of A$1 billion or more;54 or
- a member of a group of entities consolidated for accounting purposes in which another group member is a global parent entity with annual global income of A$1 billion or more.
A bill55 to broaden the definition of SGE was introduced into Parliament on 12 February 2020 but not passed at the time of writing.
From 1 July 2017, the DPT aims to ensure SGEs pay tax that reflects the economic substance of their activities in Australia'.
The DPT applies only to SGEs56 earning more than A$25 million revenue in Australia and requires that the SGE, or a foreign entity associate, entered into or carried out a scheme for which a principal purpose was to obtain an Australian or foreign tax benefit.
If applied, the DPT will result in a 40 per cent penalty rate of tax being levied on the affected entity, which must be paid upfront. The DPT is intended to minimise the information asymmetry present in transfer pricing cases by shifting the onus to taxpayers to provide transfer pricing analysis before the ATO pursues litigation.
The MAAL was Australia's unilateral legislative response to PE avoidance schemes. The MAAL applies to schemes entered into from 1 January 2016 if under, or in connection with, the scheme:
- a foreign SGE supplies goods or services to an Australian customer;
- an Australian associate or commercially dependent entity undertakes activities directly in connection with the supply;
- some or all of the income derived by the foreign entity is not attributable to an Australian PE; and
- a principal purpose of the scheme is to obtain an Australian tax benefit or foreign tax benefit.57
Where the Commissioner determines that the MAAL applies, any tax benefits arising under the scheme can be cancelled and penalties imposed.58
The MAAL has largely achieved its intended effect of onshoring profits from sales to Australian customers. In December 2019, the ATO announced that:
- with the assistance of the MAAL, Google settled its tax dispute with the ATO by paying an extra $481.5 million on top of their previous tax payment; and
- as at December 2019 the operation of the MAAL had resulted in A$7 billion in taxable sales being returned to Australia.59
We expect that there will continue to be a shift away from complex structures that seek to avoid PEs in Australia as a result of the MAAL.60
Activities and tax concessions
Australia does not have income tax rate differentials for industry sectors, other than a specialised offshore banking unit regime.61
Tax concessions are available for start-ups and certain R&D activities, including:
- refundable tax offsets, currently at a rate of 43.5 per cent for 'eligible entities' with an aggregated turnover of less than A$20 million, and non-refundable tax offsets at a rate of 38.5 per cent for all other 'eligible entities';62
- an early-stage innovation company (ESIC) tax incentive, which gives investors a 20 per cent refundable tax offset for their investment and a 10-year capital gains tax (CGT) exemption where the investment in an eligible entity is held for more than 12 months;63 and
- the start-up employee share scheme rules,64 which exempt the provision of shares or options to employees of start-up companies under compliant schemes.
Australia does not have corporate minimum capitalisation requirements. Thin capitalisation rules exist that prevent base erosion by disallowing debt deductions where the debt-to-asset ratio of Australian operations exceed prescribed debt limits. Higher limits apply to banks and financial entities.
A 'general entity'65 calculates its 'maximum allowable debt' under one of three elective methods.
The predominant method is the 'safe harbour debt amount' (SHDA). This method allows an entity to be funded by debt up to an amount equalling 60 per cent of the average value of the entity's Australian assets calculated based on the accounting balance sheet, subject to certain adjustments.66
From 1 July 2019, an entity must comply with Australian accounting standards (which are largely aligned with International Accounting Standards) in determining its assets and liabilities and calculating the value of its assets, liabilities (including debt capital) and equity capital.67 This results in entities no longer being able to recognise off-balance sheet assets or to revalue assets specifically for thin capitalisation purposes.
Entities geared above the SHDA may apply the arm's-length debt test (ALDT) or worldwide gearing debt test (WWGT).
To rely on the WWGT, foreign-controlled entities must have audited accounts demonstrating that less than 50 per cent of the group's assets are in Australia.68
The ALDT sets the debt limit based on a hypothetical amount that could be borrowed given certain assumptions, including that the entity does not have any explicit or implicit credit support. In practice, the ALDT is highly subjective and requires significant work to document.
In contrast, the WWGT permits gearing of Australian operations up to the level of the worldwide group. It is based on audited accounting values and is more objective than the ALDT.
v Common ownership: group structures and intercompany transactions
Consolidation requires the head company and subsidiary entities to be Australian tax residents.71 Australian-resident wholly owned subsidiaries of a common foreign holding company may form a multiple-entry consolidated group.
A consolidated group is treated as a single entity for income tax purposes. Tax attributes are pooled and transactions between members are disregarded, permitting the transfer of assets between wholly owned entities with no income tax implications.72 For this reason, group restructures generally make extensive use of the consolidation regime.
Assets can also be transferred tax-free between an Australian entity and a foreign resident free from CGT, provided the transferor and transferee are members of the same wholly owned group.73
Ownership structure of related parties
Tax grouping and loss sharing
Consolidation is necessary to pool tax losses in a group.74
On joining, all of the entity's carry-forward losses that could have been used outside the group at the joining time are transferred to the head company.75 Integrity rules operate to prevent losses being used at a greater rate than they would have without consolidation.76
Planning opportunities are limited and mostly involve ensuring that Australian entities do not control the CFC or that 'active income' makes up 95 per cent or more of the CFC's income,79 although this is difficult in light of an associate inclusive in-substance control test.80
Australia has repealed its foreign investor fund (FIF) rules. The FIF rules formerly taxed accrued gains on 'portfolio' interests.81
Domestic intercompany transactions
Although there are no general domestic transfer pricing rules, limitations exist on the deductibility of related party expenses. Excessive payments may be characterised as distributions of profit and are consequently not deductible.82
Limitations also exist on the deductibility of related party expenditure. For example, deductions for related party expenditure are not generally available until the period in which the recipient treats the receipt as assessable.83 A full list of similar integrity rules is beyond the scope of this chapter.
MIT non-arm's length income
The MIT rules uniquely contain specific non-arm's length income (NALI) rules.84 If the Commissioner determines an amount to be NALI, the trustee is taxed at the corporate rate on the excess of the NALI amount over the hypothetical arm's-length amount, minus deductions that are referable only to the amount of the excess.85 The NALI rule is an integrity rule aimed at preventing the abuse of the 15 per cent withholding tax rate. It will generally apply to businesses that derive rental or similar passive income such as property funds or infrastructure assets.
International intercompany transactions
Australia has a robust international transfer pricing regime that is supported by the application of the DPT to SGEs and country-by-country reporting obligations effective from 1 January 2016.86 The transfer pricing regime operates on an arm's-length principle and permits the ATO to adopt a reconstruction approach to determining the impermissible transfer pricing benefit.87
The 2017 Chevron case 88 provided judicial guidance on applying the transfer pricing provisions to cross-border related-party financing. The Court held that an arm's-length rate of interest should not be determined as if the subsidiary were a company separate from the rest of the group. This will have significant implications for pricing cross-border debt in multinational groups, as the subsidiary will need to account for the group's creditworthiness. The principles outlined in Chevron were reaffirmed in the 2019 Glencore case in which Glencore succeeded against the ATO.89
Australia also participates in information exchange under both the Foreign Account Tax Compliance Act (FATCA) and Common Reporting Standard (CRS) regimes.90
Australia's CGT regime applies to related party transactions.
Australian residents are subject to CGT on a worldwide basis.
Foreign residents are only subject to CGT on assets that are 'taxable Australian property',91 including real estate in Australia or CGT assets used in an Australian PE.
Integrity rules exist to deem a transfer to be at market value if the transaction is not at arm's length.92
Tax is payable on net capital gains, while a capital loss may be offset against capital gains or carried forward to later income years.93 Companies are entitled to carry forward capital losses provided they have either substantially maintained the same ownership and control or carried on the same business.94
The operation of the CGT rules means that cross-border related party transactions may have Australian tax implications where the vendor is an Australian entity or where the asset is land or an interest in a land rich entity. No CGT implications arise for foreign entities where the asset is not land or an interest in a land-rich entity.
vi Third-party transactions
The taxation implications of third-party transactions depend on whether the transaction is on revenue or on capital account, which is a question of fact. This subsection addresses third-party transactions on capital account, generally including divestment of investments and like transactions.
Sales of shares or assets for cash
Australian companies may reduce their capital gains from disposals of shares in a foreign company under a participation exemption.95
The exemption requires the Australian company to have held a 'direct voting percentage' of 10 per cent or more in the foreign company throughout a 12-month period that began no earlier than 24 months before the time of disposal. Under the exemption, the gain is reduced by a percentage reflecting the foreign company's 'active business' asset use. The relevant percentage reduction is calculated by a market value or book value method at the taxpayer's election.96 If that percentage is greater than 90 per cent, the gain is reduced by 100 per cent.
There is no other relief on a cash sale of assets.
Tax-free or tax-deferred transactions
Scrip for scrip
In a takeover involving the issue of some shares, a vendor may be able to defer paying CGT until a later CGT event to the extent of the scrip consideration. The exchange should be carefully structured so the same arrangement is offered to all shareholders of the same class.97 This rollover does not permit an exchange of shares for units or vice versa; however, it does permit a rollover of redeemable preference shares (RPS) even if they are treated as debt for income tax purposes. Importantly, if RPS are 'voting shares' for the purposes of the Corporations Act 2001, they must be able to participate in the exchange.98
There is no specific rollover available for the exchange of tangible or intangible assets other than in specific circumstances (e.g., when the asset is damaged).99
Rollover relief may apply to the interposition of a new holding company between a company and its shareholders,100 where interests in a newly incorporated holding company are issued to all of the shareholders in exchange for all of their interests in the original company (and nothing else).101
An entity may choose to rollover a capital gain or loss arising from a demerger of entities from a group, provided a number of eligibility conditions are satisfied.102
One criterion is that shareholders of the head entity must acquire shares in the demerged entity, and nothing else (of value). The ATO previously accepted that demerger tax relief would apply where the shareholders of the demerged entity sold their shares after the demerger (e.g., under a takeover), provided the demerger was not conditional on the subsequent share sale occurring.
The ATO's draft Taxation Determination (TD 2019/D1)105 gives the following examples:
- demerger tax relief will be available where a head entity is sold after a subsidiary is demerged pursuant to a takeover bid that is legally and commercially independent of the demerger;106 and
- where a subsidiary is demerged with the intention of preparing the head entity for sale, the 'nothing else' requirement will not be satisfied (where it is shown that the demerger was unlikely to have occurred except to prepare for the head entity's sale).107
The ATO has expressed the view that relief is not available where a demerger is followed by a share sale as the 'nothing else' requirement is not met, in some cases even absent conditionality between the two.108 This view in the draft determination is controversial as it had not been previously announced and no public guidance or explanation has been provided.
Rollover relief will be available where an individual, partner or trustee disposes of the assets of a business to a wholly owned company.109 This is commonly done as part of an exit from a business operated as a sole trader or through a discretionary trust.
The balance sheet of the business must be managed to ensure that the liabilities assumed by the company do not exceed the sum of the market value of precluded assets110 and the cost base of the non-precluded assets. There is frequently difficulty in satisfying this requirement where the value of the business is largely internally generated goodwill.
There is no specific rollover for intangible assets.
Liquidation dividends sourced in profits are assessable as dividends. Liquidation proceeds not attributable to profits are treated as capital proceeds of liquidation and may trigger a capital gain. No specific relief is available.111
Two noteworthy issues arise in relation to third-party cross-border transactions.
First, key integrity rules around interest withholding tax-free financing only apply where the counterparty is an unrelated non-resident financier. For example, the public offer test is deemed to have been failed if the financier is a related third party.112
Secondly, claw-back rules can apply to the sale of shares. CGT event J1 applies where there was previously a rollover of a capital gain on transfer of an asset between members of a wholly owned group. The tax liability is triggered if the transferor and transferee cease to be wholly owned. Any share sale structuring should take account of this possibility.113
vii Indirect taxes
The GST is a broad-based (value added) tax of 10 per cent applying to most goods, services and other items sold or consumed in Australia. A number of goods and services are exempt from GST, in particular, many medical goods and services, most 'basic' food, and exports.
Registration for GST is mandatory for Australian businesses with a GST turnover exceeding A$75,000, increasing to A$150,000 for non-profit organisations.
Non-resident entities are required to register if they are carrying on an enterprise and have a GST turnover from sales connected with Australia exceeding A$75,000.
The 'Netflix Tax', applicable from 1 July 2017, imposes GST on sales of imported services and digital products to purchasers that are 'Australian consumers',114 being an Australian resident who is either:
- not a business registered for GST; or
- purchases the product for non-business use.
Several other indirect taxes in Australia are limited to specific industries or products. For example, luxury car tax of 33 per cent is imposed on vehicles over the relevant inflation indexed threshold;115 and wine equalisation tax is imposed at 29 per cent of the wholesale value of wine, payable by entities making, wholesaling or importing wine into Australia.
Fuel tax credits provide businesses with a credit for excises or customs duty that was included in the price of fuel used in machinery, plant, equipment and vehicles travelling off public roads.116
International developments and local responses
i OECD-G20 BEPS initiative
Australia has implemented a number of measures supporting international tax transparency in response to the OECD BEPS Action Plan, making cross-border arbitrage more difficult.
Automatic exchange of information: common reporting standard (Action Item 5)
CRS legislation applies in Australia from 1 July 2017. The first exchange of information occurred in 2018. Australia has taken a 'wider approach' to CRS by requiring financial institutions to report all tax-residence details of a person opening an account, irrespective of whether the person is resident in a jurisdiction that has adopted the CRS.117
Country-by-country reporting (Action Item 13)
Australia's country-by-country (CbC) reporting rules applied from 1 January 2016 and are intended to assist the ATO in gathering reliable information for transfer pricing risk assessments. Broadly, an entity will have CbC reporting obligations for an income year if it is an SGE that was an Australian tax resident or a foreign entity with an Australian permanent establishment during the income year.118
An Australian entity that files a CbC report in another jurisdiction can be exempted if the ATO can obtain that report from the relevant tax authority.
Hybrid mismatch rules (Action Item 2)
Hybrid mismatch rules apply in Australia to income years commencing from 1 January 2019.119 We expect these rules will eliminate tax-driven cross-border use of hybrids and will result in significant and prompt restructuring of existing hybrid financing.
The rules are intended to deter the use of arrangements that exploit differences in tax treatment of an entity or financial instrument under cross-border income tax laws that result in double non-taxation or long-term tax deferral. This is achieved by denying tax deductions or including amounts in assessable income to neutralise the benefit.120
A broad integrity provision also applies to certain deductible interest or derivative payments made to an interposed foreign entity where the foreign income tax rate on the payment is 10 per cent or less.121
The MLI allows Australia and its treaty partner countries to swiftly modify their bilateral tax treaties to implement measures designed to better address multinational tax avoidance.
The introduction of a principal purpose test is expected to be the most far-reaching amendment for structuring work.
It is expected to add another weapon in policing treaty shopping, particularly coupled with the ATO's early intervention strategy through the FIRB process. In future, it will be critical to ensure that all entities in an offshore structure have commercial substance.
Australian law has been amended to explicitly require that the arm's-length principle be applied consistently with the OECD's Aligning Transfer Pricing Outcomes with Value Creation, Actions 8–10 Final Reports.124
The harmonisation of transfer pricing guidance and additional detail on key risk areas is expected to reduce future opportunity for transfer pricing arbitrage.
ii EU proposals on taxation of the digital economy
Australia recognises that its revenue collections are particularly exposed to the effects of globalisation, as Australia relies more heavily on corporate income tax than comparable OECD countries.125
A Treasury discussion paper released in October 2018 considered alternatives for adapting Australia's corporate tax system to a digitalised economy.126 The paper raised the possibility of Australia unilaterally adopting digitalised businesses turnover taxes similar to the one proposed by the EC, pending a multilateral solution.127 Following stakeholder consultation, on 20 March 2019, the Treasury announced that it would continue engaging in a multilateral process and will not proceed with an interim unilateral measure.128
Separately, the ATO has a dedicated tax avoidance workforce that targets artificial tax minimisation structures employed by multinational enterprises (MNEs) in the e-commerce and digital economy industry,129 and has addressed key tax issues130 including:
- transfer pricing – determining the arm's-length outcome for Australian subsidiaries of e-commerce MNEs with inbound supply chains;
- permanent establishments – identifying the existence of a PE under the relevant double tax agreement, noting that the issues with PEs have lessened in light of the MAAL;
- royalty withholding tax – characterising payments made by Australian software distributors to offshore licensors for royalty withholding tax purposes;131 and
- GST – enforcing the Netflix Tax discussed earlier.
iii Tax treaties
Australia has income tax treaties (DTAs) with 45 countries, comprising all developed countries and many major developing countries including China, India and Indonesia. Australia does not have a DTA with Hong Kong.
Australia's DTAs are intended to prevent double taxation of the same taxpayer in respect of the same income; however, they are not designed to prevent taxation of different entities on the same income.
Australia has limited DTAs with tax havens,132 which generally allocate taxing rights over certain income of individuals and contain procedures addressing transfer pricing adjustments.
Separately, Australia has Tax Information Exchange Agreements (TIEAs) with several non-OECD countries, including Bermuda, the British Virgin Islands, the Cayman Islands and Guernsey.
These TIEAs provide for exchange of information between participating countries on civil tax and criminal matters, with a view to eliminating harmful tax practices.133
The extension of the DTA and TIEA networks is another plank in the ATO's data collection and matching strategy targeting abuse of the cross-border tax system.
Notable typical or model provisions
The structure of Australia's DTAs broadly conform to the OECD Model Tax Convention on Income and on Capital,134 meaning Australia is largely in line with its OECD partners in respect of the content of its treaties.
Under this model, recipients of dividends, interest and royalties (DIR) in treaty countries benefit from reduced rates of withholding tax.
The following table summarises the possible range of reduced withholding rates135 (noting the specific rate depends on the DTA).
|Payment||Non-DTA country||DTA country|
|Dividend||30 per cent||zero per cent to 20 per cent|
|Interest||10 per cent||zero per cent to 5 per cent|
|Royalty||30 per cent||zero per cent to 25 per cent|
Dividends paid to non-residents are exempt from dividend withholding tax (WHT) except when paid out of profits of a company that have not borne Australian tax (i.e., 'unfranked' dividends). Unfranked dividends paid to non-residents are exempt from dividend WHT to the extent that the dividends are declared by the company to be conduits for foreign income. A deduction is allowed in certain cases to compensate for the company tax on inter-entity distributions where these are paid by holding companies to a 100 per cent parent that is a non-resident. Dividends paid to a non-resident in connection with an Australian PE are taxable to the non-resident on a net assessment basis (i.e., the dividend and associated deductions will need to be included in the determination of the non-resident's taxable income, the dividend is not subject to dividend WHT), and a franking tax offset is allowable to the non-resident company for franked dividends received.
The withholding tax rate on MIT distributions is reduced from 30 per cent to 15 per cent for recipients who are tax residents of a country with which Australia has an exchange of information agreement (EOI). EOIs are distinct from TIEAs. As at 1 January 2020, 122 countries have an EOI with Australia.136
Recent changes to and outlook for treaty network
Aside from the changes effected by the MLI, recent changes to Australia's treaty network include:
i Perceived abuses
MNE integrity bill
The government has recently enacted legislative changes139 to address risks to Australia's corporate tax base, which will impact a broad range of sectors that rely on foreign investment, including infrastructure, funds management and real estate.
The changes include:
- imposition of a 30 per cent withholding rate from 1 July 2019 on payments made by a MIT to a foreign investor where the payments are attributable to income derived from certain cross-staple MIT arrangements,140 residential housing and agricultural assets;
- foreign pension funds only being eligible for Australian withholding tax exemptions on distributions of interest and dividends where they have a portfolio-like interest in the paying entity and do not exert relevant influence over the entity; and
- changes to thin capitalisation rules to prevent double-gearing arrangements that involve multiple levels of flow-through entities (i.e., trusts or partnerships) each issuing debt against the same underlying asset.
Among the guidance issued by the ATO, Taxpayer Alerts stand out for their stated purpose of acting as 'early warning to the community about a new or emerging activity that is causing the ATO concern'.141
Entities that have entered, or continue to enter the arrangements identified in the Alerts will ordinarily be the subject of increased scrutiny. Alerts in recent years have focused on cross-border transactions. For example, 2018 Alerts focused on the mischaracterisation of payments to foreign entities who supply the use of intangible assets to Australian companies resulting in underpayment of royalty withholding tax142 and withholding tax deferral schemes.143 A 2019 Alert identified the risk of MEC (multiple entry consolidated) groups avoiding CGT through intra-group debt.144 A 2020 Alert outlines the ATO's concerns about cross-border arrangements that mischaracterise Australian activities connected with the development, enhancement, maintenance, protection and exploitation (DEMPE) of intangible assets.145 The concern is whether the activities performed by Australian entities in relation to the DEMPE of intangible assets are appropriately recognised and rewarded with reference to transfer pricing principles and whether any migration of intangible assets complies with Australian laws, including under transfer pricing, CGT and depreciation rules. These Alerts highlight the trend in the ATO targeting transactions that appear to lack commercial rationale or substance, or both.
In March 2019, legislation came into force to provide specific whistle-blower protection, including in the taxation context.146 This is expected to improve the Commissioner's access to leaks. Broadly, to qualify for protection as a tax whistle-blower, a person must be in a specific relationship with the person or entity being reported (e.g., an employee, a dependant or a spouse) and the report must be made to an eligible recipient who is in a position to take appropriate action (e.g., an internal auditor).
ii Recent successful tax-efficient transactions
There have not been any recent notable Australian examples of successful tax-efficient transactions, mainly because of the ATO's increasing involvement in developing tax policy and its increasingly robust administration of tax laws.147
The ATO is targeting tax exploitation schemes following the Paradise Papers leak. The leak has alerted the ATO to schemes aggressively marketed by big Australian accounting firms148 and the possibility of seeking civil penalties under Australia's promoter penalty provisions.149 To date, the ATO's practice has been to accept enforceable voluntary undertakings150 from accounting and law firms to stop promoting, marketing and encouraging tax exploitation schemes.151 While these undertakings have allowed the ATO to quickly end promotion activity, the legality of the schemes and advisers' roles has not been judicially tested.152
iii Limited partnerships
In Commissioner of Taxation v. Resource Capital Fund IV LP,153 the Full Federal Court of Australia dealt with Australia's right to tax profits made by fiscally transparent Cayman Islands LPs on their sales of Australian shares.154 The case raises several important points for foreign investors (particularly private equity investors) in Australian companies, including that:
LPs are separate taxable entities that are liable to Australian tax in the same way that a company is,155 despite LPs not having legal personality in the same way that a company does.156 For Australian tax purposes, the relevant taxable entities were not the partners of the LPs.
Each LP was not entitled to rely on the US–Australia DTA as each LP did not satisfy the dual requirement157 to be a US 'resident' within the meaning of Article 4(1)(b)(iii) of the DTA. That was because the LPs were organised under the laws of the Cayman Islands (and thus could not be tax residents of the United States) and the LPs were not liable to pay tax in the United States.158
The profits made by the LPs on their sales of Australian shares had an Australian source, having regard to the significant amount of investment management services provided by individuals in Australia throughout the investment term and the fact that the share sales occurred under schemes of arrangement in Australia (such that the schemes were the 'proximate' origin of the profits earned).159
iv Definition of 'associate'
The High Court of Australia dismissed the taxpayer's appeal on 11 March 2020 in BHP Billiton Limited v. Commissioner of Taxation.160 The issue was whether two arms of a dual-listed company were 'associates' of one another, and in particular whether one had 'sufficient influence' over the other.161 The term 'associate' in Section 318 is used frequently throughout Australian tax legislation – for example, in the thin capitalisation rules, the CFC rules and the CGT rules.
The Full Federal Court had earlier held that the concept was broad enough to:
include circumstances of mutually advantageous decision-making by parties as equals acting in accordance with the direction, instructions and wishes of each other for the common economic goal of operating a single economic entity.162
The High Court held that the legislation in question did not support the contention that 'sufficiently influenced' requires the controlling entity to be in effective control of the other entity.163. While the case does not create a definitive test for 'sufficient influence', it expands the scope of the concept, which is used extensively in integrity rules throughout Australian tax law.
v Foreign company tax residency
The Bywater case164 involved four foreign incorporated companies that traded shares on the Australian Securities Exchange. The issue was whether these taxpayers were Australian tax residents.
The foreign incorporated taxpayers tried to make it seem, through a number of artificial arrangements, that they were controlled and managed by entities or people outside of Australia.
The High Court held that the artificial arrangements entered into were merely to record and implement decisions made by an individual based in Australia and accordingly, the companies' central management and control were in Australia.
Significantly, the High Court cast doubt on the long-standing principle, previously supported by case law and the ATO, that a company will not be a resident if it does not carry on business in Australia. While this portion of the decision of the High Court is not binding, the ATO has revised its guidance to toughen its position in the wake of Bywater.165
Consequently, foreign companies with decision-makers present in Australia should revisit their governance protocols to confirm they are not Australian residents.
Outlook and conclusions
Australia has continued to focus on curtailing tax avoidance by multinational entities. Significantly, many of the legislative measures brought in by the Australian government, such as the MAAL, DPT, CbC reporting and anti-hybrid rules, stem from the OECD's BEPS Project, confirming Australia's status as an early mover on addressing multinational tax avoidance.
A number of initiatives have been introduced to enhance compliance with, and confidence in, the Australian tax system, including whistle-blower protections, formation of working parties and the more rigorous 'justified trust' approach. The ATO is simultaneously encouraging taxpayers to engage early with the ATO and actively seeking a seat at the table in M&A transactions through FIRB processes.
Australia has also strengthened its commitment to promoting itself as an innovation hub, particularly for start-up companies. Innovation programmes including the R&D and ESIC tax concession incentives are intended to encourage establishment of innovative businesses in Australia. These initiatives ensure that while Australia's headline corporate tax rate is higher than other countries in the region, it remains a competitive place for innovation start-ups.
Finally, a number of cases have recently passed through Australia's superior courts that may have a significant effect on taxation in Australia, especially in the context of international transactions, touching on issues including treatment of hybrid entities, transfer pricing rules and residency.
The tax landscape in Australia is changing. It is evident from the attitudes of the government, the ATO and even the Australian courts, that Australia is undertaking a zero-tolerance approach to tax avoidance, and intends to be at the forefront of combating tax avoidance globally.
1 Robert Yunan is a special counsel and Patrick Long and Wendy Lim are associates at MinterEllison.
2 The ATO also looks at whether the 'right' amount of tax on profit is being recognised in Australia (using an 'effective tax borne' methodology to compare an economic group's total worldwide profit from Australian-linked business operations with the Australian and offshore tax paid on that profit). A copy of this methodology is available by contacting the ATO.
3 The 'Top 100' programme targets public and multinational businesses (at the economic group level) that are the largest contributors to Australian income tax, GST, excise and petroleum rent resource tax collections.
4 The 'Top 1000' programme is aimed at multinational companies with turnover above A$250 million.
5 This includes the issue of 'Taxpayer Alerts', 'Practical Compliance Guidelines' and 'Public Rulings' to communicate the ATO's compliance focus areas, administrative practice and interpretation of tax laws.
6 The ATO has been achieving a high success rate. In the 2017–18 financial year, 79 per cent of reported litigation outcomes were fully favourable to the ATO and in the 2018–19 financial year this number was 74 per cent – see ATO 'Annual report' QC 33427 (last modified 20 November 2019, accessed 17 February 2020) at www.ato.gov.au/about-ato/commitments-and-reporting/annual-report-and-other-reporting-to-parliament/annual-report/. This trend has made it increasingly important for taxpayers to obtain tax advice that is subject to LPP from external tax legal practitioners.
7 Section 353-10 of Schedule 1 to the Taxation Administration Act 1953 (Cth).
8 Section 353-25 of Schedule 1 to the Taxation Administration Act 1953 (Cth), which replaced Section 264A of the Income Tax Assessment Act 1936 (Cth) (ITAA 1936).
9 The ATO will generally observe taxpayers' claims for confidentiality when exercising its formal powers, however, the above administrative concessions are not legally binding on the ATO and can be waived by the ATO.
10 ATO 'Guidelines to accessing professional accounting advisers' papers' QC17796 (last modified 7 June 2019, accessed 17 February 2020) at www.ato.gov.au/General/Gen/Guidelines-to-accessing-professional-accounting-advisers--papers/.
11 ATO Practice Statement Law Administration PS LA 2004/14 (ATO access to advice for a corporate board on tax compliance risk) at paragraph 1E.
12 ATO 'National Tax Liaison Group key messages 30 November 2018: Attachment A – Supplementary Information' webpage QC 57874 (last modified 11 February 2019, accessed 17 February 2020) at www.ato.gov.au/General/Consultation/In-detail/Stewardship-groups-minutes/National-Tax-Liaison-Group/National-Tax-Liaison-Group-key-messages-30-November-2018/?page=2.
13 ATO 'LPP Working Group' QC 58299 (last modified 17 January 2020, accessed 17 February 2020) at https://www.ato.gov.au/General/Consultation/Consultation-groups/Special-purpose-working-groups/LPP-Working-Group/.
14 These associations are Chartered Accountants Australia and New Zealand, CPA Australia, Law Council of Australia and Tax Institute Australia.
15 Glencore International AG & Ors v Commissioner of Taxation  HCA 26.
16 There are 'standard' tax conditions which can include compliance with tax laws, payment of all outstanding Australian taxes and annualised reporting. Specific conditions relating to capital gains tax, transfer pricing or thin capitalisation are increasingly being imposed. An example is that the taxpayer must contact the ATO to enter into negotiations with the ATO on transfer pricing matters within 90 days of the transaction completing.
17 Employers are also subject to taxes on fringe benefits provided to employees and associates of employees in respect of their employment under the Fringe Benefits Tax Assessment Act 1986 (Cth). No death duties are imposed in Australia.
18 The Commissioner has the general administration of the Taxation Acts of the Commonwealth – see for example Section 1-7 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997).
19 Generally stamp duty is levied at approximately 5.5 per cent, but surcharges of up to 7 per cent for foreign residents can apply.
20 Lodged returns become 'deemed assessments' under section 166A of the Income Tax Assessment Act 1936 (Cth) (ITAA 1936).
21 See generally Section 170 of the ITAA 1936.
22 The PAYG system operates to assist workers and businesses in meeting their end of year tax liabilities as the payee obtains a credit for the amounts withheld and remitted to the ATO against their tax liability when they lodge their return. Taxpayers will generally obtain a refund where their PAYG credits exceed their ultimate tax liability for the relevant tax period.
23 This rate will increase to 10 per cent from 1 July 2021 and will eventually increase to 12 per cent from 1 July 2025.
24 See public ruling SGR 2009/2 for an explanation of the phrase 'Ordinary Time Earnings'.
25 This includes the Australian Charities and Not-for-profits Commission (ACNC).
26 This involves registration for a tax file number (a unique identifier for the tax and superannuation systems), as well as registration for an ABN (similar to a VAT number) and for participation in the GST system (if required). Registrations for the PAYG system and the FBT system are typically also undertaken at the same time. The taxpayer will separately need to register with State and Territory Revenue authorities for payroll taxes if they have employees (or deemed employees) in the relevant jurisdictions, subject to a payroll threshold.
27 Under the tax consolidation rules, when one consolidated group acquires another consolidated group, there is deemed to be no deconsolidation. Structures which establish a new group consisting of a cleanskin parent and subsidiary in order to consolidate prior to the acquisition of the head company of a group have been attacked by the ATO under the general anti-avoidance rule in Part IVA of the ITAA 1936 if the deconsolidation would have given rise to a CGT leakage.
28 Division 6 of the ITAA 1936. However, in certain circumstances, trusts can be taxed like companies under Division 6C of the ITAA 1936. Broadly this is where a trust is a public unit trust and carries on an active trading business. Division 6C is an integrity rule that is designed to prevent the benefits of flow through taxation applying to public trading businesses.
29 A 'present entitlement' arises where the beneficiary has a vested and indefeasible interest in the income or capital of a trust. There are specific instances when the trustee withholds and pays tax on behalf of the beneficiaries, such as when the beneficiary is a foreign resident and the payment is not otherwise subject to withholding taxes. In these circumstances the beneficiary is required to lodge a return and claim a credit for the tax withheld on its behalf.
30 Section 99 of the ITAA 1936.
31 Distributions include dividends and non-capital distributions on instruments which have been classified as tax law equity interests.
32 The availability of a credit is subject to a number of integrity rules, including rules against 'streaming' of benefits to shareholders who would benefit more from franking credits, benchmark rules that require the franking percentage of all dividends in the same period to be the same and rules denying the credit where equity interests have not been held at risk for an adequate holding period before receipt of the distribution.
33 In these circumstances, there are multiple layers of taxation – one at the entity level and one at the shareholder level, although the imputation system ensures that there is no double taxation of dividend income, which is a feature of the classical dividend systems in the United States and Europe.
34 The CCIV regime has been designed to appeal to foreign investors and is intended to be promoted through the Asia Region Funds Passport. Essentially the Asia Region Funds Passport will provide a framework where managed funds can be marketed across participating economies in the Asian Region. The Australian Parliament passed amendments to Australian corporate law in June 2018 to give effect to the Asia Region Funds Passport.
35 CCIVs will only be eligible for flow-through treatment where they are widely held and their activities are limited to passive income activities. This is similar to the MIT/AMIT regimes. At the time of writing, there are serious policy concerns that if a CCIV ceases to be eligible for flow-through treatment, it will not become a franking entity. This means that there is the possibility of double taxation, unlike a MIT/AMIT, which will become a Division 6C public trading trust, which is an eligible franking entity. This issue remains subject to consultation.
36 The proposal is to have an attribution-style tax system similar to the existing AMIT rules. The CCIV can be subject to tax where it does not make sufficient distributions of income to its members or where it ceases to be eligible for flow-through treatment.
37 Division 830 of the ITAA 1997.
38 Broadly, the Australian partners will be subject to tax on the foreign income but should obtain a tax offset for any foreign tax paid.
39 Broadly dividend income from foreign entities in which the Australian company has a stake of at least 10 per cent: see subdivision 768-A of the ITAA 1997. The CGT exemption under subdivision 768-G of the ITAA 1997 is also subject to a non-portfolio exemption and is discussed in further detail in this paper.
40 Subdivision 768-G of the ITAA 1997.
41 Tax-deferred distributions (TDD) are cash distributions which are sheltered by tax depreciation deductions in the trust. The recipient's tax basis in their units is reduced by the TDD component, meaning they generally only pay tax on disposal, and in those cases generally at the lower long-term CGT rate.
42 A special 15 per cent final withholding tax rate applies on distributions from a MIT to non-resident unitholders in countries with which Australia has a treaty or Exchange of Information Agreement. This is likely to be substantially better than the tax rate for foreign individuals or companies.
43 There are integrity rules that prevent income splitting to minors by applying the top marginal rate to passive income of minors above a very low threshold, however, some degree of income splitting is a feature of the system and is tolerated by the ATO. An example of the ATO's views on income splitting is contained in Ruling IT 2330.
44 The eligibility criteria are broadly an aggregated turnover test subject to an integrity rule that prevents the reduced rate from applying to entities whose income is 80 per cent or more passive. This reduced rate will decrease further over time to 25 per cent from the income year beginning 1 July 2021.
45 This is currently A$18,200, meaning that when combined with the low income tax offset individuals do not pay income tax on the first A$20,542 of income (figures for the 19/20 income year). There is no married or household filing in Australia, although returns do require disclosure of a spouse's income and benefits to assist in means-testing of government benefits and other tax concessions.
46 The key integrity rule is an anti-stuffing rule which prevents the discount from being available broadly where more than 50 per cent of the assets by value or cost base have been held for less than 12 months at the time of the CGT event – see section 115-45 of the ITAA 1997.
47 There are integrity rules preventing a capital gains discount from flowing through certain trusts.
48 'Source' has been said to be a practical, hard matter of fact and not a legal question in Nathan v. Federal Commissioner of Taxation (1918) 25 CLR 183. There are some statutory rules prescribing source, including Section 160ZZX of the ITAA 1936, which deems income of an Australian branch of a foreign bank to have an Australian source and Section 6C of the ITAA 1936, which deems royalties to have an Australian source in certain circumstances. That said, there have been a plethora of cases discussing source. At a high level, a good rule of thumb appears to be that the location of a contract is indicative of source in respect of passive income but the location of the people providing the services is indicative of the source of service income.
49 The credit is referred to as a foreign tax offset under Division 770 of the ITAA 1997. The offset is generally capped at the lower of foreign tax paid on an item of assessable income or the Australian tax payable on that income. Unused offsets do not carry forward.
50 Division 802 of the ITAA 1997.
51 Australia adopts a model which allocates income to activities of the branch – it does not tax on a functionally separate entity basis.
52 Section 960-555 of the ITAA 1997.
53 A 'global parent entity' is one that is not controlled by another entity according to accounting principles, or if these principles do not apply, commercially accepted principles relating to accounting: see Section 960-560 of the ITAA 1997.
54 The Commissioner is empowered to make a determination that a global parent entity is an SGE if global financial statements have not yet been prepared by that entity for the relevant period, and the Commissioner reasonably believes that, had they been prepared, the entity's annual global income would have been A$1 billion or more. Such a determination may be challenged pursuant to the formal taxation dispute framework in Part IVC of the Taxation Administration Act 1953.
55 Treasury Laws Amendment (2020 Measures No. 1) Bill 2020 (Cth).
56 A range of entities are excluded from the operation of the DPT, including foreign entities owned by a foreign government, foreign pensions funds, foreign collective investment vehicles with wide membership and managed investment trusts.
57 Section 177DA of the ITAA 1936.
58 Penalties will be doubled for those entities that cannot demonstrate a documented reasonably arguable tax position.
59 ATO 'ATO nets another e-commerce victory' QC 61026 (last modified 18 December 2019, accessed 17 February 2020) at https://www.ato.gov.au/Media-centre/Media-releases/ATO-nets-another-e-commerce-victory/.
60 The ATO 'anticipates an additional A$7 billion in sales revenue will be returned to the Australian tax base each year as a result of the MAAL': see Commissioner of Taxation Annual Report 2017–18, p. 20.
61 The OBU regime is currently the subject of potential reforms for abuse of the 10 per cent concessional tax rate – see for example Josh Frydenberg MP 'Amending Australia's Offshore Banking Unit Regime' at https://joshfrydenberg.com.au/latest-news/amending-australias-offshore-banking-unit-regime/ and International Investment 'Australia targets offshore banking units' at www.internationalinvestment.net/internationalinvestment/news/3505898/australia-targets-offshore-banking-units. In October 2018, the OECD's Forum on Harmful Tax Practices (FHTP) raised concerns regarding the offshore banking unit regime's concessional tax rate and its limited access to domestic markets. The Australian Treasury has been in ongoing dialogue with the FHTP.
62 The R&D Incentive is currently undergoing reform with a bill before Parliament (Treasury Laws Amendment (Research and Development Tax Incentive) Bill 2019), which will take effect from 1 July 2018 if passed. Under the proposed changes, the refundable tax offsets' rate will be decreased to 13.5 percentage points above an entity's tax rate and will be capped at A$4 million per annum (except in the case of clinical trials) and the non-refundable tax offsets will be based on an entity's R&D expenditure as a proportion of its total expenditure. The bill also proposes to increase the R&D expenditure threshold from $100 million to $150 million and increase the targeting of the incentive to larger R&D entities with high levels of R&D intensity.
63 To be eligible, a company must satisfy the requirements outlined in Section 360-40 of the ITAA 1997.
64 Contained in Section 83A-33 of the ITAA 1997.
65 In broad terms, a 'general entity' is an entity that is neither a financial entity nor an ADI entity.
66 The law currently permits recognition and revaluation of certain intangibles and excludes deferred tax amounts and certain pension assets and liabilities from the calculation.
67 Subsection 820-680(1) of the ITAA97.
68 Section 820-190 of the ITAA 1997.
69 Part 3-90 of the ITAA 1997.
70 A similar regime exists for grouping of entities for GST purposes.
71 Additionally, the entities must not be prescribed dual residents that is, residents of a foreign country under the relevant tax treaty.
72 See the single entity rule in Section 701-1 of the ITAA 1997 and commentary in binding public ruling TR 2011/4. On 30 January 2019 the Commissioner of Taxation issued additional guidance on the single entity rule following the 2015 Full Federal Court decision in Channel Pastoral Holdings Pty Ltd v. FCT (2015) FCR 162. A minority in the Full Federal Court held that the single entity rule operated as a 'statutory direction concerned with the calculation of a composite liability' rather than as a 'statutory fiction . . . that a subsidiary of a consolidated group is to be treated as non-existent'. This was contrary to the widely held view that the single entity rule was a statutory fiction. The Commissioner's additional guidance reaffirms the view that the subsidiary is disregarded for tax purposes. It should also be noted that the single entity rule does not apply to other taxes, such as stamp duty. Separate relief will need to be obtained under these state and territory-based regimes.
73 See subdivision 126-B of the ITAA 1997. The asset must be 'taxable Australian property' if it is being transferred to a non-resident, otherwise it could be rolled out of the Australian tax net. If it is not 'taxable Australian property' no CGT relief is available on the transfer. Additionally, a rollover will not be available if either the originating entity or the recipient entity is a member of a group in Australia that could be consolidated but has chosen not to consolidate. The policy behind this amendment is unclear other than to provide another incentive to move into the consolidation regime. The relevant explanatory material simply expresses the position that a rollover should only be available for the transfer of a CGT asset between a member of a consolidated group and a foreign resident top company but does not explain why this is the case even in respect of a transfer from the Australian group to a foreign top company (which is not dealt with at all in the examples).
74 Division 170 of the ITAA 1997 permits tax loss transfers between OBUs outside consolidation.
75 Subdivision 707-C of the ITAA 1997.
76 The mechanism is to limit the use of losses by an 'Available Fraction' allocated to each bundle of losses, calculated as the ratio of the market value of the joining entity to the market value of the consolidated group. Subdivision 707-C of the ITAA 1997 also contains rules which prevent the artificial inflation of an Available Fraction (including by means of equity injections and non-arm's length transactions) and rules that adjust the Available Fraction of each bundle of tax losses when additional losses are transferred to the head company.
77 Part X of the ITAA 1936.
78 See Parliament of Australia 'Corporate Tax Avoidance report – Part III: Much heat, little light so far' (30 May 2018) at paragraph 1.10 of Appendix 1: https://www.aph.gov.au/Parliamentary_Business/Committees/Senate/Economics/Corporatetax45th/Report (accessed 27 February 2020).
79 An exemption exists from accruals taxation where less than 5 per cent of the income is not active income under Sections 384(2)(a) and 385(2)(a) of the ITAA 1936.
80 See Section 340(c) of the ITAA 1936 which defines control as including a situation where a foreign company is controlled by a group of 5 or fewer Australian entities, either alone or together with associates (whether or not any associate is also an Australian entity).
81 Former Part XI of the ITAA 1936. These rules were complex and time consuming with little revenue obtained because of the practice of bed-and-breakfasting FIF interests. The regime was repealed in the interests of efficiency with a proposal to replace the rules with a simpler regime, however, these rules were never introduced.
82 See, for example, Deputy Commissioner of Taxation (WA) v. Boulder Perseverance Limited (1937) 58 CLR 223 and FCT v. The Midland Railway Co of Western Australia Ltd (1951) 85 CLR 306.
83 Section 82KK of the ITAA 1936. Integrity rules also exist to prevent deductions on financial instruments from arising on an accruals basis where the recipient treats the income as assessable on a cash or receipts basis, including Division 230 of the ITAA 1997 and Division 16E of Part III of the ITAA 1936.
84 Subdivision 275-L of the ITAA 1997. The Commissioner has a broad discretion to determine the amount of NALI: derived from a scheme involving a MIT and a non-MIT not dealing with each other at arm's length; more than the amount that the MIT might have been expected to derive from dealing with the counterparty at arm's length; not a distribution from a corporate tax entity; not a distribution from a trust that is not a party to the scheme; and not part of a debt safe harbour.
85 Section 275-605 of the ITAA 1997.
86 Division 815 of the ITAA 1997.
87 Under the reconstruction approach the ATO will seek to identify the notional transaction that would exist under arm's-length conditions and price that transaction in order to determine the counterfactual. The difference between the tax payable under the notional counterfactual and the actual transaction would determine the transfer pricing benefit that would be open to denial under the transfer pricing rules.
88 Chevron Australia Holdings Pty Ltd v. Commissioner of Taxation  FCAFC 62.
89 101 Glencore Investment Pty Ltd v Commissioner of Taxation of the Commonwealth of Australia  FCA 1432.
90 Division 396 of Schedule 1 to the Taxation Administration Act 1953 (Cth) provides the legislative basis for reporting to the ATO under both FATCA and CRS. Australia has an Inter-governmental Agreement with the US on implementation of FATCA.
91 See Division 855 of the ITAA 1997.
92 See Division 116 of the ITAA 1997.
93 Australia does not currently have a tax or capital loss carry back regime, although it briefly had one, which was repealed in light of the revenue impact it was having.
94 On 1 March 2019, a new similar business test was legislated under the Treasury Laws Amendment (2017 Enterprise Incentives No. 1) Act 2019. The similar business test applies retroactively to tax losses and net capital losses incurred by companies for income years beginning on or after 1 July 2015.
95 Subdivision 768-G of the ITAA 1997.
96 Section 768-510 of the ITAA 1997. Failure to make an election or apply the chosen method incorrectly can result in the default method being applied, which essentially results in 100 per cent of the gain being assessable and no capital loss being allowed.
97 In the case of Commissioner of Taxation v. Fabig  FCAFC 99, two individuals, along with other shareholders in a company, entered a share purchase agreement to dispose of the shares they held for cash and shares in a second company. The purchasing company did not pay the shareholders the same consideration for each of their shares, instead following a private shareholders agreement entered by the individuals, which resulted in them receiving consideration disproportionate to their shareholding. For example, an individual with a 50 per cent shareholding received 80 per cent of the consideration. The Full Federal Court held that the arrangement was not one in which participation was available on substantially the same terms for all shareholders, as required by paragraph 124-780(2)(c) of the ITAA 1997. Accordingly, the individuals were not entitled to rollover relief on their exchange of shares.
98 See subsection 124-780(2) of the ITAA 1997.
99 See for example subdivision 124-B of the ITAA 1997, which covers replacement rollovers where an asset is compulsorily acquired, lost or destroyed.
100 Under subdivision 615-A of the ITAA 1997.
101 The conditions for this rollover are harder to satisfy than the scrip for scrip takeover provisions outlined above as the interests received by the shareholders must be proportionate to the ones they exchange – see subsections 615-15 and 615-20 of the ITAA 1997. Where both the interposed entity rollover and the scrip for scrip takeover rollover can apply, the interposed entity rollover applies in precedence.
102 Division 125 of the ITAA 1997. There are also shareholder dividend relief provisions that may also apply where the company obtains demerger relief.
103 See Wolters Kluwer 'Goal posts move on demergers…again' (30 October 2018, Muhunthan Kanagaratnam, Julian Lian and Tina Chen) at www.wolterskluwercentral.com.au/tax/cgt/goal-posts-move-demergers/; Allens 'Has The ATO Tolled The Bell For Demerger And Acquisition Scheme Structures?' (13 July 2018, Charles Ashton, Craig Milner, Joseph Power) at www.allens.com.au/pubs/ma/cucomp13jul18.htm; Lexology 'A change in ATO approach to demergers?' (25 June 2018, Cameron Blackwood, Richard Hendriks, Toby Eggleston and Mary Hu) at www.lexology.com/library/detail.aspx?g=7a72d1d1-bb69-4229-b140-16859a1fe8c6.
104 Demergers typically occur where a conglomerate separates into two distinct businesses or a separation occurs in the context of a third party wishing to acquire one of those businesses.
105 Draft TD 2019/D1 'Income tax: what is a 'restructuring' for the purposes of subsection 125-70(1) of the Income Tax Assessment Act 1997?' released on 20 March 2019.
106 Example 4 in draft TD 2019/1.
107 Example 3 in draft TD 2019/1.
108 This ATO view has been apparent in: the ATO, in June 2018, refusing demerger tax relief for the proposed demerger by AMA Group of one of its businesses and the acquisition of its remaining business by Blackstone; and Class Ruling CR 2018/31 issued in 25 July 2018, in which the Commissioner decided not to grant demerger relief in connection with the demerger of OneMarket Limited from Westfield Corporation Limited before the acquisition of Westfield by Unibail-Rodamco. Taxpayers would typically seek a ruling from the ATO before undertaking a demerger to obtain comfort that demerger relief applies.
109 See subdivision 122-A and subdivision 122-B of the ITAA 1997.
110 Precluded assets consist of trading stock, depreciating assets, an interest in copyrights in a film and a registered emissions unit under Section 122-25(3) of the ITAA 1997. All other CGT assets are non-precluded assets.
111 See Section 47 of the ITAA 1936 and CGT event G1 in Section 104-135 of the ITAA 1997. A capital loss is usually available if the liquidator declares shares to be worthless before they are cancelled under CGT event G3 in Section 104-145 of the ITAA 1997.
112 See, for example, Section 128F(5) and Section 128F(6) of the ITAA 1936.
113 See Section 104-175 of the ITAA 1997. Similar claw back rules also apply to stamp duty relief.
114 The administrative burden of establishing both the residency and GST registration status of online consumers is the merchant's.
115 The threshold for the financial year ending 30 June 2020 is A$67,525, with a threshold of A$75,526 applying to vehicles meeting the definition of 'fuel-efficient vehicles'. Retailers, wholesalers, manufacturers and other business that sell and import luxury cars may be liable for the tax, which is applied at the rate of 33 per cent on the value of the car over the threshold.
116 The credit amount varies depending on when the fuel is acquired, the fuel type used and the activity it is used in. Eligible activities are diverse and include, among others, agriculture, mining, nursing and medical services, and industrial furnaces. Businesses must be registered for GST when they acquire the fuel and registered under the fuel tax credit regime when they lodge a claim for credits.
117 ATO 'Automatic exchange of information guidance – CRS and FATCA' webpage QC 48683 (last modified 12 February 2020, accessed 17 February 2020) at www.ato.gov.au/General/International-tax-agreements/In-detail/International-arrangements/Automatic-exchange-of-information---CRS-and-FATCA/. The broad approach adopted by Australia is motivated by expectations that more jurisdictions will adopt the CRS over time and financial institutions will enjoy cost savings by completing the CRS process fewer times. Although not an OECD BEPs measure, FATCA reporting has been in force in Australia since 1 July 2014. One observation on the interaction between CRS and FATCA is that, under CRS, financial institutions need to identify and report accounts held by US tax-resident individuals (regardless of account balances) using the specific CRS identification rules, even though these accounts may not have been reviewable under FATCA because they fell below the relevant FATCA account balance threshold before 1 July 2017.
118 The default position under Australian tax law is that the Australian reporting entity must lodge all three kinds of reports (master file, local file and CbC report) with the ATO.
119 The rules can apply to payments between 'related parties', members of a 'control group' or between parties under a 'structured arrangement'. These terms are intended to provide a gateway into Division 832, however, they are very broad and flexible concepts. The ATO has issued ATO Law Companion Ruling LCR 2019/3 'OECD hybrid mismatch rules – concept of structured arrangement' and ATO Practical Compliance Guideline PCG 2019/6 'OECD hybrid mismatch rules – concept of structured arrangement', which are intended to address these concepts. For example, the ATO's view in LCR 2019/3 is that a scheme will be a 'structured' arrangement where either the mismatch has been factored into the calculation of the return under the arrangement as agreed between the parties or where it could be objectively concluded that the hybrid mismatch was a 'design feature' of the scheme. In the Commissioner's opinion, this requires one to look at an arrangement or dealings (including any marketing of the transaction or structure) and make an objective assessment whether the relevant facts and circumstances contributing to the hybrid mismatch were included intentionally or deliberately as opposed to the hybrid mismatch outcome being merely an unintended consequence.
120 Unlike the DPT or MAAL measures, the hybrid mismatch rules do not have a materiality threshold.
121 See subdivision 832-J of the ITAA 1997. It is noted that this is in fact an integrity measure inside another integrity measure, which is almost the legislative equivalent of a matryoshka doll.
122 Among other things, Australia has opted out of the PE avoidance articles as the MAAL implements this in domestic law.
123 As at 1 January 2020, the MLI has facilitated modifications to Australia's bilateral tax treaties with Belgium, Canada, Denmark, Finland, France, India, Ireland, Japan, Malta, the Netherlands, New Zealand, Poland, Singapore, the Slovakia and the United Kingdom. The ATO predicts up to 31 of Australia's tax treaties may be modified, to varying degrees, by the MLI: see ATO webpage 'Multilateral Instrument' QC 56703, last modified 23 December 2019, accessed 17 February 2020 at https://www.ato.gov.au/General/International-tax-agreements/In-detail/Multilateral-Instrument/.
124 The OECD 2015 Reports recommended revisions to the 2010 OECD transfer pricing guidelines (OECD 'Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations' published 18 August 2010) that would further clarify the application of the arm's-length principle, including in relation to transactions involving intellectual property and the contractual allocation of risks and corresponding profits between related parties.
125 Over the period since 2000, corporate tax in Australia has ranged between 4.35 per cent of GDP and 6.66 per cent of GDP, compared to the OECD average of 2.67 per cent to 3.25 per cent of GDP (OECD 2018, Tax on corporate profits (indicator), doi: 10.1787/d30cc412-en). Around 20 per cent to 25 per cent of Commonwealth tax revenue (excluding GST) comes from company tax.
126 Australian Treasury 'The digital economy and Australia's corporate tax system: Treasury Discussion Paper October 2018' at https://static.treasury.gov.au/uploads/sites/1/2018/10/c2018-t306182-discussion-paper-1.pdf.
127 Australian Treasury 'The digital economy and Australia's corporate tax system: Treasury Discussion Paper October 2018' at page 28. The paper also refers to the possibility of treating the country where consumers of a particular good or service are located as the 'source' country for returns to marketing intangibles (such as trademarks and brand names), so as to allocate greater taxing rights to those countries – see Australian Treasury 'The digital economy and Australia's corporate tax system: Treasury Discussion Paper October 2018' at page 16.
128 Australian Treasury (The Hon Josh Frydenberg MP, Treasurer of the Commonwealth of Australia) media release 'Government response to digital economy consultation' released 20 March 2019, available at http://jaf.ministers.treasury.gov.au/media-release/045-2019/.
129 The ATO notes that as at 30 June 2018, some of the ATO's key achievements include over A$1 billion in cash collections, future revenue effects of more than A$580 million over the next four years and the completion of many complex audits on industry leading e-commerce MNEs – refer ATO 'E-commerce and digital economy outcomes for the Tax Avoidance Taskforce' webpage QC 57576 (last modified 6 December 2018, accessed 9 March 2020) at https://www.ato.gov.au/Business/Business-bulletins-newsroom/Tax-avoidance/E-commerce-and-digital-economy-outcomes-for-the-Tax-Avoidance-Taskforce/.
130 ATO webpage 'Taskforce focus on e-commerce and digital economy industry' QC 57593 (last modified 12 December 2018, accessed 17 February 2020) at www.ato.gov.au/General/Tax-avoidance-taskforce/Taskforce-focus-on-e-commerce/.
131 This has resulted in litigation in respect of the meaning of 'royalty' and the operation of Australia's tax treaties in respect of royalty payments – see for example the Full Federal Court decision in Satyam Computer Services Limited v. Federal Commissioner of Taxation  FCAFC 172. In that case, the Full Federal Court held that the payments to the taxpayer that were royalties for the purposes of the DTA but were not otherwise royalties under Australian tax law were deemed to be Australian source income by reason of Article 23 of the DTA and sections 4 and 5 of the International Tax Agreements Act 1953. Therefore they were included in the company's assessable income for Australian tax purposes.
132 Australia has DTAs with the British Virgin Islands, the Isle of Man, Jersey, Guernsey, Cook Islands, Samoa, Mauritius, Marshall Islands and Aruba.
133 In line with the OECD's Harmful Tax Practices Initiative and related Global Forum on Taxation.
134 Key provisions of Australia's DTAs in line with the OECD Model Convention relate to permanent establishments, income from real property, business profits, dividends, interest and royalties, employment income, income of entertainers and sportspersons, pensions/annuities and income in respect of government service. Residency and tie-breaker rules are also covered. Generally, newer DTAs make specific provision for taxing capital gains, whereas older DTAs (signed before 1985) generally do not.
135 Some DTAs allow for higher maximum withholding rates than the rates prescribed under Australian domestic tax law.
136 See Regulation 34, Taxation Administration Regulations 2017 (Cth).
137 Convention between the Government of Australia and the Government of the State of Israel for the Elimination of Double Taxation with Respect to Taxes on Income and the Prevention of Tax Evasion and Avoidance.
138 Australia's updated DTA with Germany entered into force on 7 December 2016, replacing the 1972 DTA. Australia's updated DTA with Switzerland entered into force on 14 October 2014, replacing the 1980 DTA.
139 Treasury Laws Amendment (Making Sure Foreign Investors Pay Their Fair Share of Tax in Australia and Other Measures) Act 2019 (Cth) and Income Tax (Managed Investment Trust Withholding Tax) Amendment Act 2019 (Cth).
140 These arrangements were described in Taxpayer Alert 2017/1. Broadly they consist of cross-staple payments of rent that are then distributed to non-resident unitholders of a MIT with the benefit of a 15 per cent withholding tax. The ATO's concern is that the taxpayer has artificially split the business into a rental stream and an operating business to take advantage of the MIT concession.
141 Practice Statement Law Administration PSLA 2008/15 – Taxpayer alerts at page 1.
142 See TA 2018/2. The ATO notes in the Alert that: 'Our concerns include whether intangible assets have been appropriately recognised for Australian tax purposes and whether Australian royalty withholding tax obligations have been met. Arrangements that allocate all consideration to tangible goods and/or services, arrangements that allocate no consideration to intangible assets, and arrangements that view intangible assets collectively, or conceal intangible assets, may be more likely to result in a mischaracterisation.' Example 1 in the Alert focuses on undivided consideration paid to a foreign company for tangible and intangible goods with no part being treated as being for the IP, which the parties acknowledge has been provided to the Australian entity. Example 2 addresses the use of an IP company that implicitly licenses the use of IP to an Australian company but does not receive any payment for the use of the IP.
143 See TA 2018/4. The ATO is concerned with tax-driven structuring to produce a current deduction but deferral of withholding tax, for example by accruing interest without capitalising or crediting the interest under the terms of an artificial instrument.
144 See TA 2019/1.
145 See TA 2020/1.
146 Treasury Laws Amendment (Enhancing Whistleblower Protections) Act 2019 (Cth).
147 This trend has been observed since the appointment of Chris Jordan as Australia's Commissioner of Taxation on 1 January 2013.
148 See for example, Australian Financial Review 'Deloitte, EY, KPMG, PwC targeted by ATO' (8 October 2018, Neil Chenoweth) at www.afr.com/news/policy/tax/tax-office-targets-deloittes-ey-kpmg-pwc-as-tax-scheme-promoters-20181008-h16cjz and Business Insider 'The ATO is reportedly coming after the big four accountancy firms for tax schemes' (9 October 2018, Chris Pash) at www.businessinsider.com.au/ato-tax-promoter-penalties-big-four-deloitte-ey-kpmg-pwc-2018-10.
149 Although introduced in 2006, these provisions have only been successfully applied four times. The ATO litigated four matters against scheme promoters and the Federal Court of Australia imposed civil penalties against the promoters in the following 4 cases: (1) Commissioner of Taxation v. Ludekens  FCAFC 100; (2) Commissioner of Taxation of the Commonwealth of Australia v. Barossa Vines Ltd  FCA 20; (3) Commissioner of Taxation v. Arnold (No. 2)  FCA 34; and (4) Commissioner of Taxation v. International Indigenous Football Foundation Australia Pty Ltd  FCA 528.
150 See further ATO 'Report schemes and promoters' webpage QC 33634 (last modified 19 November 2019, accessed 5 March 2020) at www.ato.gov.au/general/tax-planning/report-schemes-and-promoters/.
151 See Australian Financial Review 'Tax Office has 50 secret agreements to stop advisers promoting exploitation schemes' (23 October 2018, Edmund Tadros) at www.afr.com/business/accounting/tax-office-has-50-secret-agreements-to-stop-advisers-promoting-exploitation-schemes-20181019-h16u4u.
152 See Australian Financial Review 'Give ATO power to make promoter agreements public, says tax expert' (30 October 2018, Edmund Tadros and Tom McIlroy) at www.afr.com/business/accounting/give-ato-power-to-make-promoter-agreements-public-says-tax-expert-20181024-h17116.
153  FCAFC 51.
154 In this case, the Full Federal Court reversed the decision of the Federal Court in Resource Capital Fund IV LP v. Commissioner of Taxation  FCA 41, in which the single judge held: (1) LPs were not separate taxable entities, meaning that the relevant taxable entities were the limited partners. As the taxpayers, eligible US-resident partners were entitled to the benefit of the US–Australia DTA.; and (2) the LP's sale of shares in the Australian company had an Australian source, despite the LP and its partners being located overseas. This was because of the significant amount of investment management services provided by individuals in Australia throughout the investment term.
155 Certain 'corporate limited partnerships' are taxed as companies under the rules applicable to limited partnerships in Division 5A of the ITAA 1936.
156 At  and .
157 In Resource Capital Fund III LP v. Commissioner of Taxation (2013) 95 ATR 504, Edmonds J at first instance (at –) formed the view that the definition of a 'resident' in Article 4(1)(b)(iii) of the US–Australia DTA imposed a dual requirement to be satisfied, namely that the partnership was a resident of the United State for tax purposes and the income of the partnership had to be subject to United States tax.
158 At  to .
159 At .
160  HCA 5
161 See subsection 318(6)(b) of the ITAA 1936.
162 Commissioner of Taxation v BHP Billiton Limited  FCAFC 4 at 15 (Allsop CJ).
163  HCA 5 at 40.
164 This is a reference to the decisions of the High Court of Australia in Bywater Investments Ltd & Ors v. Commissioner of Taxation and Hua Wang Bank Berhad v. Commissioner of Taxation reported at  HCA 45.
165 See Taxation Ruling TR 2018/5 and Practical Compliance Guideline PCG 2018/9, which reflect this view that a company can be a resident of Australia merely through the exercise of central management and control in Australia, without any trading or other traditionally active business activities being carried on in Australia. This ATO guidance means that taxpayers face considerable uncertainty with respect to whether they will be considered a resident of Australia.